Residual value insurance is “insurance” for federal income tax purposes

Residual value insurance

The U.S. Tax Court today issued an opinion concluding that “residual value insurance”—a contract that insures against the risk that the residual value of an asset, when returned at the end of a lease, will be significantly lower than the expected value—as sold by the taxpayer constituted contracts of “insurance” for federal income tax purposes.

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The Tax Court found that the risks insured by the taxpayer’s policies covered an insurance risk.  The case is: R.V.I. Guaranty Co. Ltd. v. Commissioner, 145 T.C. No. 9 (September 21, 2015).  Read the Tax Court’s opinion [PDF 210 KB]

Summary

The taxpayer sold contracts for “residual value insurance.” Parties insured under these contracts included leasing companies, manufacturers, and financial institutions. The assets insured included passenger vehicles, commercial real estate, and commercial equipment. 

The insured parties were the lessors of these assets or provided financing for such leases. When pricing a lease, a lessor had to estimate what residual value the asset will have when it was returned at the end of the lease. 

The taxpayer insured against the risk that the actual value of the asset upon termination of the lease would be significantly lower than the expected value.

The IRS determined that these policies did not constitute insurance for federal income tax purposes, based on a determination that the lessors were purchasing protection against an investment risk, not an insurance risk. Therefore, the IRS concluded that the taxpayer was not an “insurance company” (entitled to compute its taxable income using the insurance accounting rules under section 832) and assessed an income tax deficiency of approximately $55 million for the 2006 tax year.

The Tax Court today held that the policies were insurance for federal income tax purposes.

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